Question

You are a manager in a start-up firm based in Bengaluru. The firm is planning to go public and you have been tasked at arriving at an approximate valuation for the firm. The firm is in the business of providing medical grade pure water. The asset beta of the firms’ in the industry with similar size is 1.3 and 1.4. The risk free rate is 5% and the market risk premium is 7%. At present, the firm doesn’t have any debt, however the management intends to target a debt equity ratio of 1. The cost of debt for similar firms with similar capital structure is 8.5%. What is the WACC of the firm given the intended capital structure ? What should be the value of the firm if the Free cash flow to the firm you have arrived at is INR 12 million and is expected to grow at a rate of 2% in perpetuity

Answer 1

For calculating the beta of this firm , a simple average of beta of comparable companies could be taken because the asset beta is given which is already unlevered.

beta = ( 1.3 + 1.4 ) / 2 = 1.35

Cost of equity = rf + b*(rp)

rf = risk free rate = 5%

b = 1.35

rp = 7%

Cost of equity = 0.05 + 1.35*(0.07) = 14.45%

a)

Wacc = [ (cost of equity * weight of equity) + (cost of debt * weight of debt) ]

Weight of equity = 50% ( debt equity ratio being 1:1 )

Weight of debt = 50%

WACC = [ (14.45 * 0.5) + (8.5 * 0.5) ] = 11.47%

b)

Enterprise value = FCFF / (r-g)

FCFF = free cash flow to firm = 12 mn

r (WACC) = 11.47%

g = growth = 2%

b)

Enterprise value = 12 / ( 0.1147- 0.02 ) = 126.72 mn